The Age of Unicorns

Stewart Butterfield had one objective when he set out to raise money for his startup last fall: a billion dollars or nothing. If he couldn’t reach a $1 billion valuation for Slack, his San Francisco business software company, he wouldn’t bother. Slack was hardly starving for cash. It was a rocket ship, with thousands of people signing up for its workplace collaboration tools each week. What Slack needed, Butterfield believed, was the cachet of the billion-dollar mark.

“Yes, it’s arbitrary because it’s a big round number,” says Butterfield, 41. “It does make a difference psychologically. One billion is better than $800 million because it’s the psychological threshold for potential customers, employees, and the press.”

Illustration by Jeremy Enecio for Fortune

Sure enough, in October—less than a year after the company released its namesake product—Slack announced the close of a $120 million round of financing. Its valuation? One billion dollars. Butterfield’s wish had come true: Slack was the tech world’s newest “unicorn.”

It wasn’t long ago that the idea of a pre-IPO tech startup with a $1 billion market value was a fantasy. Google GOOG was never worth $1 billion as a private company. Neither was Amazon AMZN nor any other alumnus of the original dotcom class.

Today the technology industry is crowded with billion-dollar startups. When Cowboy Ventures founder Aileen Lee coined the term unicorn as a label for such corporate creatures in a November 2013 TechCrunch blog post, just 39 of the past decade’s VC-backed U.S. software startups had topped the $1 billion valuation mark. Now, casting a wider net, Fortune counts more than 80 startups that have been valued at $1 billion or more by venture capitalists (full list here). And given that these companies are privately held, a few are sure to have escaped our detection. The rise of the unicorn has occurred rapidly and without much warning, and it’s starting to freak some people out.

“It used to be that unicorns were these mythical creatures,” says Jason Green, a venture capitalist at Emergence Capital Partners whose investments include Yammer, which sold to Microsoft MSFT for $1.2 billion. “Now there are herds of unicorns.”

Not content to run with the pack—or “blessing,” as a group of unicorns is sometimes known—venture capitalists have begun targeting even bigger game. They’re now hunting startups with the potential to rapidly reach a $10 billion valuation—or, as Green calls them, “decacorns.” In late 2013 just one private company had crossed that threshold: Facebook FB. Now there are at least eight, including Uber, the on-demand car service worth $41.2 billion. Its valuation is higher than the market capitalization of at least 70% of the companies in the Fortune 500.

Technology is driving the boom. Smartphones, cheap sensors, and cloud computing have enabled a raft of new Internet-connected services that are infiltrating the most tech-averse industries—Uber is roiling the taxi industry; Airbnb is disrupting hotels. Investors see massive opportunity in the upheaval.

Then there are the broader financial trends. A nearly six-year-old raging bull market in public stocks has produced a tailwind for private company valuations and convinced the latest crop of tech entrepreneurs that there will be plenty of time to cash in when they feel like it. Record-low interest rates also have caused some big institutional investors to search for returns in the high-risk, high-reward world of venture capital. Add to that a lack of regulation: After the passage of the JOBS Act in 2012, which aimed to make it easier for small businesses to raise capital, startups could take on many more investors before the Securities and Exchange Commission effectively forced them to go public.

Finally, there is the intangible element of perception. In the startup world, a valuation of $1 billion says that you’re no longer a fly-by-night startup with plans to quickly sell out to Google.

“It absolutely gives us credibility and the ability to hire some very important people,” says Apoorva Mehta, the 28-year-old CEO of on-demand grocery delivery service Instacart, which has been in business for only two years but reportedly is valued at $2 billion. “And it tells the world that we’re looking to build a long-lasting worldwide brand instead of looking to get acquired.”

Venture capitalists justify these soaring valuations by looking backward. After the dotcom crash, a wave of prudence swept over the Valley. Investors kept valuations low and tried not to overcapitalize their companies. That strategy lasted until Hurricane Facebook came along. All of the cautious types who passed on investing in the social network early, because it was too expensive at $250 million or $500 million, were left scarred and paranoid when it went public in May 2012 with a market cap of $104 billion. If a startup is going to be worth billions of dollars in a few years, why quibble over a few million on the entry price?

As a result, the median valuation of a Series A round of funding soared 135% between 2012 and 2014, according to the law firm Cooley LLP. This has created an echo effect, with new gains setting the bar higher for each subsequent round of funding. So venture capitalists have recruited unlikely new partners in the form of traditional money managers such as Fidelity Investments (which led the latest deal for Uber) and Wellington Management (which backed DocuSign and Moderna Therapeutics) to support unicorn-level rounds. Call it trickle-up economics.

It also doesn’t hurt that American corporations have record-breaking stockpiles of cash on their balance sheets. Facebook set tongues wagging when it paid $19 billion for instant-messaging startup WhatsApp last March, then followed it up a month later by shelling out $2 billion for virtual reality headset maker Oculus VR. In 2014, Google paid $3.2 billion for smart thermostat maker Nest, Apple AAPL acquired headphone maker Beats for $3 billion, and Microsoft spent $2.5 billion to own the Swedish gaming startup responsible for Minecraft. Even health care VCs cashed in, selling Seragon Pharmaceuticals to Genentech for upwards of $1.7 billion.

(Click thumbnail to see full graphic)

All of this has begun to feel bubblicious, especially to those who lived through the last cycle. “If you are a CEO today and you’re age 35 or below, you did not go through 2000, which means you have not actually seen the capital markets shut off,” says venture capitalist Marc Andreessen, who nonetheless remains bullish. “People who went through 2000 are psychologically scarred and arguably have been risk-averse for the last 15 years. If you didn’t go through it you’re in danger of always believing you can raise money at a higher valuation.”

Greycroft Partners founder Alan Patricof, who has been investing in startups for more than four decades, is wary. “People are buying traffic growth and revenue growth, but it’s the ‘emperor has no clothes’ theory,” he says. “At some point all of these companies will be valued on a multiple of Ebitda. If the IPO market goes away, or for any reason there’s a blip in the outlook, people could be left holding a lot of inventory they wish they didn’t have.”

Proponents of the unicorn boom posit that this time—no, seriously!—is different. Many of the billion-dollar startups, they argue, have the actual customers and revenue that companies of the dotcom days lacked. But no one in the VC world is so sanguine as to suggest that, sooner or later, we won’t experience a market pullback.

Not surprisingly, many venture capitalists have begun preaching caution to their portfolio companies. A brief swoon in publicly traded tech stock prices last April—particularly in the enterprise sector—was seen industrywide as a warning shot that startups should control their “burn rates” and raise as much new money as possible to protect against a future funding drought. Entrepreneurs listened, at least to the second part: U.S.-based companies raised more venture capital in the fourth quarter of 2014 than they did in any other quarter over the prior 13 years, according to the National Venture Capital Association.

That explains, in part, why a company like Instacart raised $120 million in new funding earlier this month at its reported $2 billion valuation just six months after raising $44 million at a $400 million valuation. Or why social media company Pinterest raised $625 million over three rounds of funding between February 2013 and May 2014, doubling its valuation from $2.5 billion to $5 billion.

But more aggressive fundraising is no guarantee that unicorns will grow into their valuations. “Going from $0 to $50 million in revenue is a lot different from going from $50 million to several hundred million,” says Green. “A lot of folks don’t make that transition. Most don’t. Maybe half of those companies won’t fulfill their potential.” (For a look at a startup struggling to break through, read the story on Jawbone.)

Several unicorns have already experienced a pullback. Open-source software company Hortonworks HDP was valued at $1 billion by private investors but lowered its market cap to $666 million when it went public last December. (It has since crossed back over the $1 billion mark in market value.) Box, the data storage company credited with making enterprise technology cool, was preparing to hold an IPO just days after this magazine went to press. Its initial valuation was expected to be at least 30% lower than the $2.4 billion it commanded from private investors like TPG Capital last summer.

And then there is Fab, the design-focused e-commerce site that said it would generate $250 million in revenue in 2013. It ended up bringing in around $100 million. (At one point, it burned as much as $14 million per month.) Fab shrank from 750 employees to 150, and CEO Jason Goldberg repositioned the company as a custom furniture business. Fab was widely reported to have raised some of its $336 million in funding at a $1 billion valuation, but Goldberg acknowledges to Fortune that its valuation never actually topped $875 million. He acknowledges the company isn’t worth close to that today. “If you allow yourself to believe you’re worth $1 billion after two to three years of being in business, you’re going to get yourself caught up in trouble,” Goldberg says.

Even in the best of times, of course, startup investing is high risk. As quickly as the Age of Unicorns arrived, the conditions that created it could reverse and leave entrepreneurs and investors wistful for what might have been.

“I think you’re going to see a lot of failure in 2015,” says Benchmark Capital partner Bill Gurley, who sits on Uber’s board of directors. “If you’re a public company worth $3 billion and your stock trades down to $1 billion, you can survive it because you can still issue options to hire new employees, etc. If it happens when you’re private, though, it becomes immediately harder to hire or to get incremental investment.”

In the meantime, expect more billion-dollar startups to emerge—at least for now. “You can’t choose not to play,” Gurley says. “If you’re in the enterprise segment and your competitors are raising $150 million at high valuations and pouring it into sales, you either can do something similar or be conservative and no longer matter.” Which might explain why some VCs continue to invest even as they predict failure. There’s always the hope and belief that the value created by a few successful unicorns will offset the losses of those that fail.

Butterfield knows the easy venture money will dry up at some point. It’s one reason Slack has spent only 1% of the money it’s raised. “You’d have to be in a meteors-hitting-the-Earth scenario before Slack as a business would get into trouble,” he boasts. Staying thrifty is a smart move. The prestige of being a unicorn diminishes with each passing quarter. When it’s gone, he’ll have a whole new fantasy to chase: profitability.

Additional reporting by Daniel Roberts and Deena Shanker.

This story is from the February 2015 issue of Fortune.

Correction, January 23, 2014: The original version of this story misstated Fab’s revenue in 2013; it is $100 million. The $30 million figure originally stated in the article was the company’s revenue in 2014.

Stewart Butterfield had one objective when he set out to raise money for his startup last fall: a billion dollars or nothing. If he couldn’t reach a $1 billion valuation for Slack, his San Francisco business software company, he wouldn’t bother. Slack was hardly starving for cash. It was a rocket ship, with thousands of people signing up for its workplace collaboration tools each week. What Slack needed, Butterfield believed, was the cachet of the billion-dollar mark.

“Yes, it’s arbitrary because it’s a big round number,” says Butterfield, 41. “It does make a difference psychologically. One billion is better than $800 million because it’s the psychological threshold for potential customers, employees, and the press.”

Illustration by Jeremy Enecio for Fortune

Sure enough, in October—less than a year after the company released its namesake product—Slack announced the close of a $120 million round of financing. Its valuation? One billion dollars. Butterfield’s wish had come true: Slack was the tech world’s newest “unicorn.”

It wasn’t long ago that the idea of a pre-IPO tech startup with a $1 billion market value was a fantasy. Google GOOG was never worth $1 billion as a private company. Neither was Amazon AMZN nor any other alumnus of the original dotcom class.

Today the technology industry is crowded with billion-dollar startups. When Cowboy Ventures founder Aileen Lee coined the term unicorn as a label for such corporate creatures in a November 2013 TechCrunch blog post, just 39 of the past decade’s VC-backed U.S. software startups had topped the $1 billion valuation mark. Now, casting a wider net, Fortune counts more than 80 startups that have been valued at $1 billion or more by venture capitalists (full list here). And given that these companies are privately held, a few are sure to have escaped our detection. The rise of the unicorn has occurred rapidly and without much warning, and it’s starting to freak some people out.

“It used to be that unicorns were these mythical creatures,” says Jason Green, a venture capitalist at Emergence Capital Partners whose investments include Yammer, which sold to Microsoft MSFT for $1.2 billion. “Now there are herds of unicorns.”

Not content to run with the pack—or “blessing,” as a group of unicorns is sometimes known—venture capitalists have begun targeting even bigger game. They’re now hunting startups with the potential to rapidly reach a $10 billion valuation—or, as Green calls them, “decacorns.” In late 2013 just one private company had crossed that threshold: Facebook FB. Now there are at least eight, including Uber, the on-demand car service worth $41.2 billion. Its valuation is higher than the market capitalization of at least 70% of the companies in the Fortune 500.

Technology is driving the boom. Smartphones, cheap sensors, and cloud computing have enabled a raft of new Internet-connected services that are infiltrating the most tech-averse industries—Uber is roiling the taxi industry; Airbnb is disrupting hotels. Investors see massive opportunity in the upheaval.

Then there are the broader financial trends. A nearly six-year-old raging bull market in public stocks has produced a tailwind for private company valuations and convinced the latest crop of tech entrepreneurs that there will be plenty of time to cash in when they feel like it. Record-low interest rates also have caused some big institutional investors to search for returns in the high-risk, high-reward world of venture capital. Add to that a lack of regulation: After the passage of the JOBS Act in 2012, which aimed to make it easier for small businesses to raise capital, startups could take on many more investors before the Securities and Exchange Commission effectively forced them to go public.

Finally, there is the intangible element of perception. In the startup world, a valuation of $1 billion says that you’re no longer a fly-by-night startup with plans to quickly sell out to Google.

“It absolutely gives us credibility and the ability to hire some very important people,” says Apoorva Mehta, the 28-year-old CEO of on-demand grocery delivery service Instacart, which has been in business for only two years but reportedly is valued at $2 billion. “And it tells the world that we’re looking to build a long-lasting worldwide brand instead of looking to get acquired.”

Venture capitalists justify these soaring valuations by looking backward. After the dotcom crash, a wave of prudence swept over the Valley. Investors kept valuations low and tried not to overcapitalize their companies. That strategy lasted until Hurricane Facebook came along. All of the cautious types who passed on investing in the social network early, because it was too expensive at $250 million or $500 million, were left scarred and paranoid when it went public in May 2012 with a market cap of $104 billion. If a startup is going to be worth billions of dollars in a few years, why quibble over a few million on the entry price?

As a result, the median valuation of a Series A round of funding soared 135% between 2012 and 2014, according to the law firm Cooley LLP. This has created an echo effect, with new gains setting the bar higher for each subsequent round of funding. So venture capitalists have recruited unlikely new partners in the form of traditional money managers such as Fidelity Investments (which led the latest deal for Uber) and Wellington Management (which backed DocuSign and Moderna Therapeutics) to support unicorn-level rounds. Call it trickle-up economics.

It also doesn’t hurt that American corporations have record-breaking stockpiles of cash on their balance sheets. Facebook set tongues wagging when it paid $19 billion for instant-messaging startup WhatsApp last March, then followed it up a month later by shelling out $2 billion for virtual reality headset maker Oculus VR. In 2014, Google paid $3.2 billion for smart thermostat maker Nest, Apple AAPL acquired headphone maker Beats for $3 billion, and Microsoft spent $2.5 billion to own the Swedish gaming startup responsible for Minecraft. Even health care VCs cashed in, selling Seragon Pharmaceuticals to Genentech for upwards of $1.7 billion.

(Click thumbnail to see full graphic)

All of this has begun to feel bubblicious, especially to those who lived through the last cycle. “If you are a CEO today and you’re age 35 or below, you did not go through 2000, which means you have not actually seen the capital markets shut off,” says venture capitalist Marc Andreessen, who nonetheless remains bullish. “People who went through 2000 are psychologically scarred and arguably have been risk-averse for the last 15 years. If you didn’t go through it you’re in danger of always believing you can raise money at a higher valuation.”

Greycroft Partners founder Alan Patricof, who has been investing in startups for more than four decades, is wary. “People are buying traffic growth and revenue growth, but it’s the ‘emperor has no clothes’ theory,” he says. “At some point all of these companies will be valued on a multiple of Ebitda. If the IPO market goes away, or for any reason there’s a blip in the outlook, people could be left holding a lot of inventory they wish they didn’t have.”

Proponents of the unicorn boom posit that this time—no, seriously!—is different. Many of the billion-dollar startups, they argue, have the actual customers and revenue that companies of the dotcom days lacked. But no one in the VC world is so sanguine as to suggest that, sooner or later, we won’t experience a market pullback.

Not surprisingly, many venture capitalists have begun preaching caution to their portfolio companies. A brief swoon in publicly traded tech stock prices last April—particularly in the enterprise sector—was seen industrywide as a warning shot that startups should control their “burn rates” and raise as much new money as possible to protect against a future funding drought. Entrepreneurs listened, at least to the second part: U.S.-based companies raised more venture capital in the fourth quarter of 2014 than they did in any other quarter over the prior 13 years, according to the National Venture Capital Association.

That explains, in part, why a company like Instacart raised $120 million in new funding earlier this month at its reported $2 billion valuation just six months after raising $44 million at a $400 million valuation. Or why social media company Pinterest raised $625 million over three rounds of funding between February 2013 and May 2014, doubling its valuation from $2.5 billion to $5 billion.

But more aggressive fundraising is no guarantee that unicorns will grow into their valuations. “Going from $0 to $50 million in revenue is a lot different from going from $50 million to several hundred million,” says Green. “A lot of folks don’t make that transition. Most don’t. Maybe half of those companies won’t fulfill their potential.” (For a look at a startup struggling to break through, read the story on Jawbone.)

Several unicorns have already experienced a pullback. Open-source software company Hortonworks HDP was valued at $1 billion by private investors but lowered its market cap to $666 million when it went public last December. (It has since crossed back over the $1 billion mark in market value.) Box, the data storage company credited with making enterprise technology cool, was preparing to hold an IPO just days after this magazine went to press. Its initial valuation was expected to be at least 30% lower than the $2.4 billion it commanded from private investors like TPG Capital last summer.

And then there is Fab, the design-focused e-commerce site that said it would generate $250 million in revenue in 2013. It ended up bringing in around $100 million. (At one point, it burned as much as $14 million per month.) Fab shrank from 750 employees to 150, and CEO Jason Goldberg repositioned the company as a custom furniture business. Fab was widely reported to have raised some of its $336 million in funding at a $1 billion valuation, but Goldberg acknowledges to Fortune that its valuation never actually topped $875 million. He acknowledges the company isn’t worth close to that today. “If you allow yourself to believe you’re worth $1 billion after two to three years of being in business, you’re going to get yourself caught up in trouble,” Goldberg says.

Even in the best of times, of course, startup investing is high risk. As quickly as the Age of Unicorns arrived, the conditions that created it could reverse and leave entrepreneurs and investors wistful for what might have been.

“I think you’re going to see a lot of failure in 2015,” says Benchmark Capital partner Bill Gurley, who sits on Uber’s board of directors. “If you’re a public company worth $3 billion and your stock trades down to $1 billion, you can survive it because you can still issue options to hire new employees, etc. If it happens when you’re private, though, it becomes immediately harder to hire or to get incremental investment.”

In the meantime, expect more billion-dollar startups to emerge—at least for now. “You can’t choose not to play,” Gurley says. “If you’re in the enterprise segment and your competitors are raising $150 million at high valuations and pouring it into sales, you either can do something similar or be conservative and no longer matter.” Which might explain why some VCs continue to invest even as they predict failure. There’s always the hope and belief that the value created by a few successful unicorns will offset the losses of those that fail.

Butterfield knows the easy venture money will dry up at some point. It’s one reason Slack has spent only 1% of the money it’s raised. “You’d have to be in a meteors-hitting-the-Earth scenario before Slack as a business would get into trouble,” he boasts. Staying thrifty is a smart move. The prestige of being a unicorn diminishes with each passing quarter. When it’s gone, he’ll have a whole new fantasy to chase: profitability.

Additional reporting by Daniel Roberts and Deena Shanker.

This story is from the February 2015 issue of Fortune.

Correction, January 23, 2014: The original version of this story misstated Fab’s revenue in 2013; it is $100 million. The $30 million figure originally stated in the article was the company’s revenue in 2014.